Amortization The Payment till Death
October 10th, 2007 Categories: Mortgage News
Refinancing a house for a lower monthly payment and/or cash-out is almost as common as applying for a new credit card. Saving $100 per month on your mortgage payment seems like worthy reason to rewrite the debt on a home, penny saved, penny earned right? Not necessarily.
Traditional mortgages are written with payback terms applied against an amortization payment schedule, typically figured over a 30 year term.Even shorter fixed term, Adjustable Rate Mortgages (ARM’s), use a 30 year amortization schedule to determine the monthly payment, i.e. a 5-Year ARM’s payment is still figured over a 30 year amortization schedule.
Recently 40 year and 50 year amortized loan products have made their way into the available product section at any of your favorite mortgage peddlers, stretching out the pay-back period and thus reducing required monthly payment amounts.
What doesn’t get disclosed are some of the following facts about amortized loans:
On a 30-Year amortization schedule with an 8% interest rate, the first payment is allocated with ~90% going towards interest and ~10% going towards principle.For every $1000 in payment, $900 towards interest and $100 towards paying off the debt. It’s worse for the 40-50 year loans.
This disparity only improves by .01% to 1% better per month (increasing as the loan ages) and it takes ~21 years before your monthly payment is equally allocated towards interest and principle, then tipping in favor of principle over interest. I don’t know anyone who keeps a mortgage for 21 years anymore…
The real financial transgression occurs when you refinance an amortized loan into another amortized loan, even if you are lowering the interest rate and monthly payment.
Below are abbreviated amortization schedules and loan terms that demonstrate how much one stands to pay for a home using a series of 4 refinances every 5 years that both lower interest rate and payments…
Assumptions:
- $100,000 is the original loan amount for simplicity.
- No cash-out transactions, i.e. only refinancing what is owed on the previous mortgage, (demonstrating a best case scenario).
- No pre-payment penalties are assumed.
- 30-Year Fixed Programs are the consistent term.
- Closing costs factored into the equation = $4000
- Payments rounded to the nearest $1.00
Purchase Loan
- Amount Financed = $100,000
- Interest Rate = 8%
- Payment = $734
60 Months later:
- Total Interest Paid = $39,096
- Total Principle Paid = $4930
- Principle Balance to be refinanced = $95,070
Refinance 1
- Amount Financed = $99,070 (Principle balance + closing costs)
- Interest Rate = 7.5%
- Payment = $692.71
60 Months later:
- Total Interest Paid = $36,230
- Total Principle Paid = $5332
- Principle Balance to be refinanced = $93,737
Refinance 2
- Amount Financed = $97,737 (Principle balance + closing costs)
- Interest Rate = 7.0%
- Payment = $650
60 Months later:
- Total Interest Paid = $33,279
- Total Principle Paid = $5736
- Principle Balance to be refinanced = $92,001
Refinance 3
- Amount Financed = $96,001 (Principle balance + closing costs)
- Interest Rate = 6.5%
- Payment = $607
60 Months later:
- Total Interest Paid = $30,274
- Total Principle Paid = $6133
- Principle Balance to be refinanced = $89,868
Refinance 4
- Amount Financed = $93,868 (Principle balance + closing costs)
- Interest Rate = 6.0%
- Payment = $563
60 Months later:
- Total Interest Paid = $27,247
- Total Principle Paid = $6520
- Principle Balance remaining = $87,347
Recap…
25 years and 4 refinances later.
- Your payment has gone down $171/Month (Yay!)
- Total Monies Paid (Interest + Principle + Closing Costs) = $214,777
- Total Remaining Payments @ 6% = $168,396
Assuming the mortgage was then taken to term:
The $100,000 original loan amount would equate to $383,173 in total expense.
Consider that if the original loan was never refinanced, the total expense would be ~$265,000 and paid off 20 years sooner.
What no Truth in Lending Act will tell you…
In effect you are leasing the home from the bank.
Refinancing an amortized loan with another amortized loan will cost you (under this scenario) 383% of the original mortgage amount.
Assuming your home doesn’t double in value and you sell or you don’t hit the lottery, you will never pay your mortgage off.
The mortgage news waves have been understandably saturated with stories of fraud, predatory lending, the sub-prime fallout, and a slew of other tragic tales about an industry that has molested consumers in the wrongest of ways. It seems like only yesterday that I was being challenged as an ignorant blow-hard who ‘slandered’ the mortgage industry without discretion.
Now it’s the rage.
It’s great to see more mortgage pundits pick up the lens of transparency and challenge the status-quo…
Blown Mortgage
The Mortgage Porter
Americas Most Opinionated Mortgage Broker
Mortgages Undressed
LendingClarity
The Mortgage Reports
Mortgage Fraud Blog
The Mortgage Lender Implode-o-Meter
Patrick.re
…all blog-sites populated by fine authors who are less concerned with being politically correct and more in tune with exposing truth.
The figures in this post are truly staggering. Goes to show that the quick fix is not the best way.
In what areas of the country are 40-50 year loan products most common?
Rebecca D. Levinson-Connect2Agent
[…] The Real Scoop on Amortization […]
I’m very honored to be mentioned on your blog. Thank you very much!
Rebecca…While 40-50 year amortized loans are available in all parts of the country, they are even a staple within Conforming guidelines, they’re most often executed in high property value areas e.g. California, coast lines, etc…
Rhonda…No need for thanks, your blog is outstanding!
In Texas, I mostly see folks refinancing to shorten the term. Usually happens around year 8 if the rates cooperate.
They take a loan with 22 years left and refi with a 15 year loan removing 7 years of “rent” to the man. The best ones I have seen are a reduction in years to pay anywhere from 5-10 years while maintaining the same payment, or even a payment reduction depending on closing costs and the lower rate spread. The shorter term packs a bigger principal wallop on the loan balance.
I think this is a result of our homestead law which prevents cashout refi’s less than 80% LTV, so the borrower uses favorable rates to get the mortgage off their back, not to go shopping.
The homestead law is looking like a model to follow, Texas looks real smart in hindsight as it never saw the crazy appreciation curve and now depreciation swing.
You can get a very nice house in Texas at a reasonable price compared to other states local markets of comparable size.
Thank you for this great info. I will use it daily when talking with my Borrower about the different loan programs and options.